AG ECONOMICS 101

Have you ever wondered how the products you purchase in grocery stores are priced? Here’s a hint – it is not an arbitrary number made up by your local producers. In fact, farmers have essentially no say when it comes to product pricing. There are many different variables that can influence the cost of your fuel, food, business operations, etc.

4-7-16baconTo explain, let’s talk about pork bacon (because everyone loves bacon). If China, the world’s largest pork producing country, increases the amount of bacon/pork it exports to other counties, the world price of bacon would decrease. The price of bacon in America, then, also decreases. This is due to excess supply, or a higher quantity of bacon than is actually desired. Consumers now have more options when it comes to purchasing bacon, so competitors will lower their prices to attract them. In comparison, if China experiences a significant loss in its swine population due to disease, less pork will be exported. This means there is less bacon available on the global market, increasing the overall price (demand is higher than supply).

4-7-16supplydemandIf US farmers charge a high price for pork products while China exports a high quantity of bacon into the world market, domestic producers will lose profit. This is because they are unable to compete with the lower Chinese prices. Think of it this way: the more of something you have, the less it is worth. The opposite is true when you have less of something – it is worth more.

To explain in more detail, let’s say you live in a town with a few hundred apple trees called Smithville. There are a handful stores that sell apples from these trees. Apples are at an average price until a new trader also decides to start selling apples in Smithville. This trader brings new apples to sell from a neighboring town. This means that there is now a higher quantity and variety of apples in your town. Has the price of apples in Smithville increased or decreased? It has decreased. Consumers now have many options to choose from, so the stores have to offer lower prices to get customers to buy their apples. This is what happens when China sells their products (pork) on the global and US markets. There are more options, so prices decrease.

4-7-16pigsOn the other hand, US farmers make larger profits when China decreases pork production and trade. Domestic producers are not immediately able to make up for that loss in supply. With less Chinese pork products flooding American markets, the competition is much thinner and prices rise. Think of it as an apple trader ending business in Smithville. The shortage of apples causes prices to increase.

If prices did not increase, other farmers would not be encouraged to join the pork industry to make up for the supply loss. We might also see a significant reduction in domestic supply, as consumers would still be purchasing their regular amounts of bacon, as opposed to less if prices were higher. With this in mind, one might expect the prices of agriculture commodities to fluctuate much more severely and frequently. While prices do change, legislative policies help keep them relatively stable. The Farm Bill, for example, has various price support programs to regulate the quantity of agriculture products on the market. These support programs include crop insurance, subsidies, conservation methods, etc.

austin fee

Austin Fee
University of Illinois

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